Hi all, financing director / LO for a major Home Improvement Company here. Ive seen this get asked quite a bit and a lot of misinformation going around so I'm going to break down the pros and cons of a few options and what that might mean for you and your wallet long term. Women lie, Men lie, Numbers dont lie. This isn't a full list, but its my honest take on the options available, in order from desirable to least desirable.
TLDR:
- Fannie Mae Homepath / FHA 203K loans
- Equity lines or Closed end second liens
- Pace / Unsecured
- HEI
Depending on your rate of your current mortgage Fannie Mae Homestyle Reno and FHA 203K loans are amazing products. Finding an LO willing to do this particular loan, is not as common, and finding a lender willing to accept this application is also difficult but not impossible. A seasoned and ethical loan officer will take your current interest rate on your 1st mortgage and compare the blended rate on any new loans you are thinking about obtaining, and compare that to a refi rate instead to make sure this program makes sense for you. If you are constrained on equity this is also a good option.
focusing on 203K loans there are 2 options (streamlined 203K for projects less than 75,000 and standard for projects above 75,000$)
can be used as a Refinance or Purchase product
lower FICO scores are accepted (less than 600)
up to 96.5% of your properties AFTER REPAIR VALUE
Can included 6 months of your mortgage payments in your new loan to help pay your mortgage if your property is inhabitable during construction
Cons:
There is mortgage Insurance feature on this loan regardless of how much down payment you are putting or how much equity you currently have
Amortizing your mortgage again (especially true if more than half of your 1st mortgage is already paid off)
Contractor must provide documentation to work with lender, and it does get meticulous. Most contractors dont want to deal with an invasive probe into their companies.
There is a 15% contingency reserve requirement which serves as a cushion for any unforseen expenses. This can be financed as well, or you can bring cash to escrow. If funds are unapplied , the money is returned immediately
Average interest rates from what i have seen in my career range from 5.750 - 7.00 %
Lenders will give you 180 days to complete all work as outlined on the bid that you sign with the contractor.
HELOC or a closed end 2nd lien option would be 2nd best due to the terms offered compared to unsecured loans
Generally these are 30 year terms with 5-10 year draws (amount of time you can use the funds in your HELOC before the lender freezes the line and you only repay the balance remaining)
AI has helped shape quite a few lenders to use alternative income for self employed borrowers with platforms like PLAID , which calculates your bank statement deposits using complex algorithms and API to determine your monthly qualifying income.
for a traditional HELOC you can get a pretty decent rate below 10% in todays market with above average - normal qualifying criteria. Digital HELOCS are a bit higher, due to them accepting the alternative incomes and taking on more risk
Third option is unsecured loans and PACE loans.
These are pretty horrible all around, BUT they do serve a few instances where it can make sense. Here is the breakdown on those.
Pros:
Fast immediate funding within 2-5 days.
Borderline 0 underwriting , heavily FICO score based
No "lien" on your house, although thats also deceptive, because they still place a UCC lien on the property.
Loan amounts up to 100,000K
Cons.
Terms are no more than 15 sometimes 20 years. and rates are well in the low teens for the most part. High Risk High Rate kind of play
Make sense for smaller repairs or improvements or if you are paying cash for the majority of the project and want a part of it financed.
Contractors are inclined to sell you a higher rate, because they get charged a DF,
i.e you apply for a loan for 100,000 through ABC construction. ABC construction is charged a 8% dealer fee if you elect an interest rate of 7.99% however they only get charged 4% Dealer fee if you elect an interest rate of 12,99%. Meaning you are going to pay 100% of the 100,000 back plus interest, and ABC construction will either be getting 92,000 or 96,000. What do you think the contractor is going to be gunning for? Whose your daddy? You guessed it.
For the 5-10% of DISCIPLINED Americans who really do not spend beyond their means and for smaller projects, Unsecured loans through companies like Service Finance (among others) offer 12 months no interest no payment loans. If its a smaller project and you have the means to complete the entire projects payments in 12 months, this is a no brainer option and would actually be the 1st option. However, due to the financial illiteracy in this country, I'm a pragmatist at best
BORROWER BEWARE : on the example just mentioned, if you do not pay the entire amount due within 12 month period on that "promotional product" then the entire remaining balance is then compounded on the interest and that rate is well in the teens. Again this isn't for everyone.
Last option absolute desperation HEI (Home equity investment loan)
This is dirty murky origination territory, and maybe its just a personal viewpoint, i just dont see any example id do something like this for.
Those loans are going to be the death of the housing market for the middle class. As if the middle class wasn’t already becoming more and more marginalized with each passing day to the point of near nonexistence.
Pros: 0 FICO score requirements 0 income requirements 0 payments
Cons- They take a haircut on the appraisals and regardless of when you choose to pay off this loan in 10 years 20 years or 30 years, no matter what way you look at it at a 5% annual average increase in property values, the banks that offer these risky loans that don’t have to adhere to policies and regulations like traditional loans, as there is absent an interest rate , actually end up costing tens of thousands of dollars more than a traditional HELOC would have.
The make their money on appreciation of your property, so taking an HEI loan to rehab your property, is like you unzipping their pants for them while you.....
lets not get carried away. If you want your heirs to your estate to be left with nothing, come on down , and sign up for an HEI loan.
Not financial advice:
We are licensed in California, Florida, and Texas